Public Finance Alert
Many issuers (including conduit borrowers) and others in the municipal market are facing unprecedented financial, operational and other challenges as a result of the spread of the Coronavirus Disease 2019 (COVID-19). At the same time, the municipal market has suffered significant disruption, particularly in the market for short term debt, with spikes in rates and possible failed remarketings for variable rate demand obligations (VRDOs) and failed rolls of commercial paper (CP). This alert will discuss principles which can be applied in analyzing the disclosure responsibilities of issuers in the context of these recent developments.
The provisions of federal securities law which will come into play in analyzing any disclosure obligations are (1) obligations under continuing disclosure agreements (CDAs) entered into in past securities offerings in compliance with SEC Rule 15c2-12, and (2) general principles under SEC Rule 10b-5 with respect to any statements or disclosures (including voluntary disclosures) made by issuers reasonably expected to reach the market. Many of these issues were raised during a webinar presented on March 19, 2020 by the Municipal Securities Rulemaking Board (MSRB), which had as a special guest Ahmed Abonamah, Deputy Director of the SEC’s Office of Municipal Securities.
CDAs all require the appropriate issuer (which may be a conduit borrower or other obligated party) to (i) prepare and file an annual financial report containing certain financial information and operating data for the prior fiscal year period and submit annual financial statements by a specified due date, (ii) if applicable, make a filing stating that an annual report or annual financial statements will not be released by the specified due date, and (iii) make a filing within 10 business days if any of certain enumerated events occurs (material event notices or MENs). All such filings are made on the MSRB’s Electronic Municipal Market Access (EMMA) website.
First, none of the 16 events (or 14 events for older issuances) for which a MEN is required specifically covers such matters as a spike in rates for VRDOs or failed remarketings or CP rolls. Issuers will nevertheless want to review their CDAs and be familiar with the events requiring immediate notice. Each individual issuer’s circumstances are unique and some of the consequences of COVID-19 may trigger a reporting requirement. For example, one of the events is a ratings change, but not a ratings watch or outlook change. Affected issuers should take care to closely follow their ratings. Another event is a draw on a credit enhancement reflecting financial difficulties of the issuer. If a bank credit facility has to be drawn because of a failed remarketing of VRDOs or roll of CP, that should not be treated as due to the issuer’s financial condition, but the circumstances should be reviewed to be sure the draw was caused by market disruption. If disruption in the short term markets results in a short delay in making a debt service payment, that is a reportable event, even if only a day or two. If the issuer makes a change in a credit provider to improve remarketing of VRDOs or roll of CP, that also has to be reported. Finally, if the CDA was entered into after February 28, 2019, a new event was added to report on any new financial obligation or amendment to an existing obligation. This event may be triggered if, for instance, an issuer enters into a new loan agreement with a bank in lieu of using a credit facility draw (this is a possible technique to allow an issuer to buy its own bonds and later reissue them as a refunding) or if the issuer modifies its bank credit agreement.
One topic discussed on the MSRB webcast was the question of what to do if the COVID-19 disruptions prevent it from making a required CDA filing on time. Could the SEC, like the IRS, just give issuers more time to report? Mr. Abonamah noted on the webinar that the SEC has no power to allow issuers to delay a filing, since the CDA is a private contract between the issuer and its bondholders, mediated by the underwriter. The SEC has no regulatory authority over issuers in this matter. An issuer must follow the terms of the CDA, which would mean, in the case of a delay in filing an annual report, it would file (as soon as it can) a notice that the annual report will be delayed, and then it must file that report and annual financial statements as soon as it can. The same applies to material event reports, except no separate notice of late filing is needed (that would be apparent from the notice itself, which would indicate the date of the event being reported). Mr. Abonamah further noted that, in making these delayed fillings, the issuer is perfectly allowed to spell out the reasons for the delay.
Another important element of Rule 15c2-12 is that an underwriter in a new issuance is required to review an issuer’s compliance with prior CDAs and make a reasonable determination that the issuer can be expected to comply with a new CDA. Mr. Abonomah indicated that when delays have been due to the impact of COVID-19, an underwriter can through its diligence process conclude that the issuer had justification for prior delays and would be able to comply with a new CDA. Similar situations have occurred in the past after natural disasters, such as hurricanes.
A final issue under Rule 15c2-12 is that if an issuer has failed to comply with a CDA obligation in a material manner, it must disclose this in future primary offering documents for five years. A question will arise as to whether such disclosure for a subsequent five years must be made if an issuer has made late filings due to COVID-19. Unfortunately, the SEC has never defined how to decide exactly when an instance of noncompliance is material to investors. Rather, issuers themselves are left to have to make that determination. The best practice is to include in future preliminary and final official statements a disclosure of the late filing and an explanation of the reason(s) for it (without making any judgment as to whether the noncompliance was material). Be aware that while an issuer may in good faith believe that, say, a late filing due to COVID-19 was not a material fact to investors, some underwriters may insist on having this disclosure in the offering documents before they will underwrite a future issue. Past experience indicates that inclusion of such disclosures generally has no adverse effect on the marketability or price of a new bond issue, particularly when the reason is set forth and was not due to shortcomings in the issuer’s continuing disclosure practices and procedures.
The fact that an issuer is suffering revenue loss, operational disruption, economic impacts, etc. from the COVID-19 virus is not, in and of itself, a reportable event under Rule 15c2-12. The MSRB webinar reiterated that there is no COVID-19 reporting obligation under a typical CDA. However, issuers may choose to make a voluntary disclosure concerning their circumstances. This is permissible and EMMA has places for voluntary or interim disclosures, but since this action would clearly be “speaking to the market” and the fact that the situation will be rapidly evolving, the disclosure must be reviewed by both financial and legal staff to ensure that it is accurate and complete as to the issuer’s circumstances (i.e. that it does not violate SEC Rule 10b-5). The disclosure should focus on the specific facts known to and affecting the issuer, and it does not have to recount matters of general information which are already available to market participants. These types of issues were discussed in a recent Staff Legal Bulletin from the SEC’s Office of Municipal Securities dated February 7, 2020.
Issuers and obligated persons should also be mindful to avoid having different officials making independent public statements regarding COVID-19, as they can also be considered as speaking to the market. It is best to make sure a single source is identified for public disclosures on the topic. One issue which has been brought up is that an issuer may likely need to update its voluntary (or required) disclosures as circumstances develop. EMMA does not permit an issuer to remove a prior filing, but it can be moved to an “archive,” and be replaced by a more current disclosure, which will be what users will find immediately when they search for information about that issuer on EMMA.
As we have discussed, an issuer may choose to make a voluntary filing or may be required to make a MEN as a consequence of the impact of COVID-19. In any event, we believe issuers must begin to think about and prepare for the next time they are required to speak to the market and consider whether they need to include a statement about the impact of COVID-19 on the issuer’s finances and operations, all while being cognizant that the situation is still evolving and any statements to the market carry potential Rule 10b-5 liability.